Muni-lease financing 101

Avoid debt by using tax-exempt leases to acquire new equipment.

As an alternative to using cash reserves to purchase equipment such as this excavator, tax-exempt municipal leases can usually be structured with flexible payment terms to meet the individual needs of government bodies. Photo: Doosan Infracore Construction Equipment America

By Doug Zoerb

Shrinking capital budgets and aging equipment fleets have states, counties, and municipalities in a bind. Caught in a vice between voter concerns about rising expenditures and the need to upgrade and replace machines used to maintain utilities, streets, and other public property, many public agencies are looking for alternative methods to acquire the equipment they need.

Traditionally, government entities have preferred to own their equipment. However, this requires dipping into increasingly scarce cash reserves, or — in the case of larger purchases — holding a voter referendum or selling bonds. With citizens wary about the slow economic recovery and government indebtedness in general, the odds aren't good that these methods will succeed.

As municipalities search for other ways to pay for equipment acquisitions, one alternative that's gaining in popularity is tax-exempt municipal leasing, also called municipal lease financing or “muni-lease.”

According to the Association for Governmental Leasing & Finance, the benefits include:

Preserving capital dollars for projects for which leasing is not an option

“Another advantage is that it allows a public entity to make payments for equipment and related services over the useful life of the asset,” says George Macia, program manager, Americas, at Doosan Infracore Financial Solutions. “It's a lease-to-own financing solution with no residual value and no end-of-lease buyout. Unlike with commercial leases, the municipality owns the equipment at the end of the term.”

The lease is typically structured as a series of renewable obligations subject to an annual or biennial appropriation by the government body involved, and payments generally come out of general, operating, or capital improvements budgets.

It typically includes a non-appropriation clause that enables the lessee to terminate the lease and deliver the equipment back to the lessor in the event that the funds are not appropriated. The non-appropriation clause will usually contain “best efforts” language requiring the lessee to use its best efforts to obtain the necessary appropriation for the lease payments.

Macia notes that municipalities shouldn't take termination of a municipal lease agreement lightly, as non-appropriation can result in the lowering of a municipality's credit rating.

Debt-free financing

Because each lease payment is approved only for the current fiscal period and paid out of current revenues, in most cases these payments aren't considered debt.

As a result, government agencies can avoid the need to hold referendums or issue bonds for equipment purchases. In addition, agencies can acquire the equipment they need and spread the cost over time, rather than acquiring equipment on a pay-as-you-go basis and using up valuable cash reserves.

Another advantage of tax-exempt municipal finance is exactly what its name implies — interest income generated by the lease and paid to the lessor is exempt from federal, and in some cases, state income taxes. This savings is generally passed on to the government body in the form of lower payments.

“Because interest income is excluded from gross income for federal income tax purposes and the savings is passed back to the government entity, this type of financing is usually the lowest-cost option available,” Macia says.

Title to the equipment acquired under a muni-lease may be retained by the lessor until all payments have been received, or may be granted to the lessee at lease inception. In most cases, it is preferable to pass the title upfront to avoid any potential tax issues.

Because a muni-lease is a “net lease,” the lessee is responsible for items such as maintenance, insurance, and other operating expenses. However, the lessee may contract with the equipment supplier to provide maintenance and other services and these costs may be included in the financing.

Any municipality or political subdivision that can issue tax-exempt securities can generally utilize tax-exempt municipal financing. Qualifying entities include states, counties, and cities; public school districts; special purpose districts (fire, park, utility, water, etc.); and other agencies and authorities. Others that may qualify include public colleges and universities, hospitals, boards and commissions, and Section 501(c)(3) nonprofit organizations.

The mechanics of acquiring equipment with muni-lease financing are similar to the process used to finance a house. The equipment being acquired is generally delivered to the government body prior to or on the date the lease is signed. At the same time, the proceeds advanced by the lease investors (normally a bank, finance company, or other financial institution) are applied simultaneously with the signing of the lease to pay the vendor the purchase price for the equipment.

In many cases, the equipment manufacturer's finance subsidiary can simplify this process by providing municipal lease financing for the parent company's equipment.

Public works officials frequently need to decide whether to buy, rent, or lease equipment to build and maintain public assets. Tight budgets and shrinking cash reserves have made these decisions even more difficult — and critical.

Owning equipment — and using cash reserves to pay for acquisitions — may not be the best strategy during this economic climate.

“I don't see that there are any advantages to acquiring equipment with cash at this time,” says George Macia, program manager, Americas, at Doosan Infracore Financial Solutions. “Municipalities need to keep as much of their cash as possible to invest in other projects or save for emergencies.”

Rental is a good option for short-term needs or when a specialized piece of equipment is required for a particular project.

“But if it's longer term — if you're going to need the machine for three years or more, for example — then you should finance the equipment,” says Macia. “Financing is going to give you a much lower payment than just renting it from a dealer.”

Macia notes that the finance division of an equipment manufacturer is a good place for municipalities to seek help with their equipment acquisition needs. Experienced representatives can help coordinate both the structuring of the financing and the delivery of the equipment, saving time and hassle.